by Archie M. Richards, Jr., CFP^®
August 11, 2003

You're 40 years old. You'd like to quit working in 25 years and retire on $35,000 annual income.

If America has inflation, as most people expect, you'll need more than $35,000. With inflation at 2 percent a year for 25 years, you'd need $57,400 a year to match the buying power of $35,000 today. But if we have benign deflation, as I expect, you'll need less than $35,000. You decide that $35,000 is about right.

Between the retirement plans you already have, you've accumulated $50,000. How much do you need to set aside from here on out to achieve your retirement goal?

If Congress privatizes Social Security, you'll receive income from that source, reducing the need for separate funds of your own. But if Congress doesn't discard its wretched pay-as-you-go system, the young people working 25 years from now won't fork over enough taxes to pay the hoard of retirees. The system will then be dying. Officials who say that Social Security has reserves are lying. There are no reserves. All Social Security money not needed for current retirees and expenses is immediately spent on whatever Congress favors that day. Congress will probably find a solution, but you can't rely on it. You assume that all of the Social Security taxes you've paid will permanently be lost.

How much capital will you need 25 years from now to provide $35,000 a year? It depends on whether you want money left over after you die. Your spouse is 35. You plan on the younger of you living to age 100. That's 65 years. If you consume your investments during your life, but still want money left over after you die, you'll need permanent life insurance. But if you withdraw only 5 percent a year from your investments during retirement, the investments should continue growing despite the withdrawals, leaving money left over after death.

Okay, 25 years from now, to supply $35,000 a year at 5 percent, you'll need capital of $700,000 ($35,000 divided by 0.05). This doesn't cover tuition and other large, non-retirement expenses you may have coming up. The funds for those are in addition to the amounts needed to attain the $700,000.

How fast will your investments grow? For at least the next couple of decades, I believe the asset allocation model recommended in www.ArchieRichards.com (the column is dated June 30, 2003) will grow at an average of 10-to-12 percent a year, pre-tax.

Outside of your retirement plans, taxes reduce the returns, of course. Bond interest is assessed at high ordinary rates. But my asset allocation model calls for only 20 percent in bonds - not much of a tax problem there. The taxes on most stock dividends and capital gains have been reduced to low levels. Overall, the tax burden on investments is moderate.

After your expected returns of 10-12 percent a year are reduced by taxes, you figure the net return will be 7 percent a year. This is probably too low, but you like to be conservative.

At 7 percent a year, the $50,000 you've already accumulated in retirement plans will grow to $270,000 in 25 years. This leaves $430,000 to go.

Your trusty financial calculator tells you that monthly additions of $531, accumulating at 7 percent a year, will reach $430,000 in 25 years. You can add them to your retirement plans, or not, as you please.

Every month for 25 years, you'll continue adding $531. But in case you die in the meantime, your family needs insurance protection on your life. According to SelectQuote (www.selectquote.com), the cost of a $1 million, 20-year term policy for a male age 40 in good physical condition is $63 a month. After a few years, you can probably reduce the amount of insurance, cutting the cost.

Between the investments ($531) and the insurance premiums ($63), you're looking at almost $600 a month. If this is more than you expected, you'd better get a move on. Cut your non-essential expenses to the bone. (See www.homeeconomiser.com) Arrange for the $531 investments and the $63 premiums to be deducted directly from your bank account. What you don't see you won't spend.

It's your future.